Home equity lines of credit (HELOCs) can be a useful financial tool for homeowners. They allow homeowners to draw funds secured against the equity in their homes, in a manner similar to using a credit card.
A term, or draw period, is set on the HELOC along with a limit of the draw amount. At the end of the term, both principal and interest are due. Some loan terms allow for refinancing, renewing the line of credit, or extending the repayment period – but others require full repayment at term’s end.
In any case, payments will increase at the end of the draw term, and by a large amount in some cases.
HELOCs were very popular in the years before the housing market’s collapse and the subsequent Great Recession. At that time, interest rates were still relatively low and houses had appreciated dramatically.
By year’s end in 2013, almost half of existing HELOC balances began in the years 2005-2007. Since the typical draw period is ten years, many of these HELOC’s draw periods will end starting next year. According to the Office for the Comptroller of the Currency, approximately $30 billion in HELOC balances will end their draw period in 2014, and over the next three years, there will be respectively $52 billion, $62 billion, and $68 billion in HELOCs with newly expiring draw periods.
Regulators fear that too many people misunderstand their HELOC terms and are in danger of defaulting and/or having difficulty paying other debts they may hold. A recent report by the credit bureau TransUnion shines some light on the depth of the problem.
There are approximately 16 million Americans with HELOC balances totaling $474 billion. More than half of those HELOCs have balances over $100,000. According to the TransUnion report, between 10-17% of these HELOCs may be at an “elevated risk” of default in the next few years, encompassing as much as $79 billion in total balances.
If you want to be an optimist, this means that 80% of the HELOC balances are likely to be repaid. Ezra Becker, a TransUnion V.P. of research and consulting, called default concerns “overblown”, further saying, “The world is not falling apart on HELOCs because there are ways to manage the risk.”
Indeed, there are ways for financial institutions to be proactive. Credit scores are an excellent indicator of default for HELOCs. Banks can make efforts to educate HELOC balance holders well before the draw term ends about their obligations.
Matt Potere, a home equity products executive with Bank of America, said that Bank of America starts contacting HELOC holders over a year before the due date to make sure they understand that higher payments are coming and to help them to prepare for the change – offering loan modifications and other programs to those in hardship on a case-by-case basis.
The real concern is in consumer understanding. Too many people do not seem to understand that their payments will rise and/or balances will become due at the end of the draw term – or even know when their draw term ends. Meanwhile, regulators are concerned that the Bank of America education example is more the exception than the rule, or that programs will not be effective.
Education programs are a good idea – but in the end, there must be a personal responsibility component. If you do not understand the terms of a loan, don’t sign the papers. We hope that most Americans understand this principle, and they will be prepared for the rise in HELOC payments and make plans accordingly.